Investors in search of fresh catalysts

The Philippines is a hot topic in the boardrooms of fund managers who are “overweight” on the country these days, but not necessarily in a positive light. Investors are jolted by President Duterte’s escalating anti-US rhetoric, which, in turn, stemmed from the US’  criticism of the spate of extrajudicial killings linked to the new administration’s all-out war on drugs.

Coincidentally, the Philippine stock market turned more cautious in the third quarter as fears over an increase in US interest rates caused an outflow of funds across regional markets.  This is mostly attributed to profit-taking ahead of the next US interest rate adjustment, now believed by many to be a done deal by December. Rising domestic political noise alongside the forthcoming US elections has also added to investors’ jitters. To begin with, the third quarter is historically a weak season for the stock market.

In the third quarter, the main-share Philippine Stock Exchange index (PSEi) shed 166.52 points or 2.1 percent to close at 7,629.73 as foreign investors turned into heavy net sellers from being heavy buyers shortly after the May 2016 presidential elections.

Despite the sluggish third quarter, the PSEi is still ahead by 677.65 points or 9.74 percent since January due to hefty gains earlier in the year.

“Foreign investors see the fundamentals and that’s why they are here in a big, big way. Flows are flows. We’ve had a very good run since January—we’re talking about 30 percent gain since February—and that’s pretty strong. Normal traders would take profits and we expect them to,” Phillip Hagedorn, investments director at ATR Asset Management, said in an interview with the Inquirer.

With the price to earnings (P/E) ratio of PSEi stocks hitting more than 20 times—which means investors were paying 20 times the amount of money they expect to make—investors with heavy exposure to Philippine equities would want to lock up their gains.

“The question is—are the longer term investors changing their mind?” Hagedorn asked.

To date, long-term investors still seemed generally upbeat on the Philippines, Hagedorn said.  They believe in the country and its growth story, apart from the fact that it’s hard to look anywhere in the world for a country with such good fundamentals.

“If we turn this into a good thing, in the next three or four months, that discussion in the boardroom will be positive. It will be very good,” Hagedorn said. “I don’t think he had slipped down to the slippery slope so much that he can’t stop it. Maybe the President could show some personal restraint, start the prosecution of drug lords, stop the extrajudicial killings and find some vigilantes responsible for those,” he said.

“But if it continues with a lot of uncertainty, with a lot of flip-flopping, with favoritism coming in, then people will rein in,” he warned. Investors can easily dump more shares as they had easily come in. However, he said investors would likely “see where this goes” first.

For the month of September alone, foreign investors were net sellers to the tune of P16.8 billion, although for the entire third quarter, there was modest net buying worth P2.4 billion. The PSEi slipped by 2.1 percent in September, tracking the peso’s weakening during the period.

“We can attribute the weakness to the following: The (US Federal Reserve Board’s) expected rate hike, Brexit (Britain’s decision to leave the European Union) woes, slowing remittances and political clattter,” investment house First Metro Investment Corp. (FMIC) and University of Asia & the Pacific (UA&P) said in a research note for September.

‘Sword of Damocles’

The US interest rate-setting hovers like a “sword of Damocles” as most of the Fed members have turned into “hawks” or biased for an interest rate increase, Ravelas said. It was more likely that the US central bank would raise interest rates by December, he added.

ATRAM’s Hagedorn said a prospective rate increase would cause shock waves in the short-term but it should be good over the longer term.  Once the US Federal Reserve is confident on raising interest rates, the fund manager said this meant that it was confident about the US and global economies.

Ravelas said cheaper valuations as a result of the recent pullback could also attract bargain-hunters.

In terms of job creation, Ravelas said the Philippine economy had performed well alongside its move to a higher trend growth that now outpaces China’s. The country’s jobless ratio had slid to an 11-year low of 5.4 percent in July from 6.5 percent a year ago.

What the country has made very little progress in, Ravelas said, was in lifting per capita gross domestic product (GDP).  At $2,850 GDP per capita—the lowest among most peers in the region—Ravelas said this was just at the same level that Thailand was 22 years ago. But being the bottom-dweller only indicated no other way to go but up.

In the next few years through 2019, Ravelas said he expected the country to sustain a GDP growth pace of 6.75 percent a year.

Dutertenomics

Ravelas added that he was bullish on the country’s future under Duterte, whom he described as the kind of leader capable of taking bold moves. He said the President would bring three Ds to the table: Direction (federalism), discipline (for individuals and corporations) and deterrence (against crime, drugs and corruption).

“What’s bringing out the Philippine story is internal growth. We’re creating more jobs than what was seen in more than 30 years,” Ravelas said, adding that progress in Metro Manila was being replicated in new growth areas in the provinces.  It was possible for the country to sustain a growth of at least 6.75 percent a year through 2019, he projected.

“There’s a sense of needing to get a lot of things done. You can argue whether it’s the right thing or not, but there’s bias for action rather than paralysis or analysis,” said Michael Ferrer, president and managing director of ATRAM.

One gray area pointed out by Ravelas is a seeming “disconnect” between Duterte and fiscal policy. “How are we going to have a lower debt burden if we’re going to spend so much?” he asked, adding that there was no clarity yet in the government’s revenue program relative to the avowed spending requirements.

The government has committed to raise infrastructure spending to at least 5 percent to as high as 7 percent of GDP.  This is widely seen as a welcome development but as long as the government could boost revenue generation given that tax cuts were also on the table.

The tax reform package proposed by fiscal managers, he said, would inevitably cause upward pressure on interest rates and inflation. “But this could be compensated by rising investment in infrastructure,” Ravelas said.

Mr. Duterte’s tax reform package seeks to reduce the maximum personal income tax from 32 percent to 25 percent and the corporate income tax from 30 percent to 25 percent. It also seeks to expand the value-added tax (VAT) base by reducing the coverage of its exemptions. The program also bats for the adjustment of excise taxes imposed on petroleum products as well as the restructuring of the excise tax on automobiles, except for buses, trucks, cargo vans, jeeps, jeepney substitutes and special purpose vehicles.

Despite the political noise, BDO Unibank chief strategist Jonathan Ravelas sees the Philippine stock market climbing to new heights, breaching the 9,000 level by next year on the back of a surge in infrastructure spending and a sustained growth in corporate earnings. It’s possible that the PSEi could revisit 8,000 by end-2016 and further test the 9,000 mark in 2017.

10-13 percent growth

The projected recovery back to the 8,000 level by yearend was seen supported by a 9-10 percent growth in average earnings per share, Ravelas said.  Next year, earnings growth is seen at 10-13 percent.

Towards yearend, investors should brace for more volatility given expectations of a Fed rate increase in December, US presidential elections, weaker peso and remnants of the 2007-2008 global financial crisis resurfacing, FMIC-UA&P said, noting the financial woes of European banking giant Deutsche Bank.

Deutsche Bank is being hounded by the US justice department’s proposal of up to $14 billion in fines related to the bank’s sale of complex structured mortgage bonds during the height of the US-epicentered global financial crisis.

“We think strong economic growth has already been priced in by investors. Unless we see robust EPS (earnings per share) growth, the market appears to lack re-rating catalysts. With external risks weighing down on investors’ sentiment, the market could remain on heightened volatility toward yearend,” FMIC-UA&P said.

The US presidential election in November is also seen as a key risk for emerging markets. BofA Merrill Lynch’s October fund manager survey showed global investor risk-aversion growing as cash allocations surge close to 15-year highs. Investors identified fears of an EU breakup, a bond crash and Republican Donald Trump winning the White House as the most commonly cited risks.

“On the local front, mixed political signals (causing some confusion on foreign and trade policies), together with regulatory changes and sweeping tax reforms, while welcome, are uncertainties that investors will have to navigate going into 2017. Having said these, we prefer to be cautious but at the same time mindful of opportunities. We would like to take advantage of extreme selloffs to position for next year,” FMIC-UA&P said.